We Think That There Are Issues Underlying Sanathan Textiles' (NSE:SANATHAN) Earnings

Despite posting some strong earnings, the market for Sanathan Textiles Limited's (NSE:SANATHAN) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

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A Closer Look At Sanathan Textiles' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2025, Sanathan Textiles had an accrual ratio of 0.61. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹1.60b, a look at free cash flow indicates it actually burnt through ₹11b in the last year. We also note that Sanathan Textiles' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹11b.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Sanathan Textiles' Profit Performance

As we have made quite clear, we're a bit worried that Sanathan Textiles didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Sanathan Textiles' underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 14% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. When we did our research, we found 2 warning signs for Sanathan Textiles (1 can't be ignored!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Sanathan Textiles' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.